How to Determine the Right Legal Entity For Your Business

When you are starting a business, one of the most important decisions to be made is determining your business entity.  As an example, when I started, I was a sole proprietor.  And honestly, it was because I didn’t know what I didn’t know.  I really thought it was a good idea to start a business, get an EIN number and start taking money.  And this mistake, which is made by more than 50% of new business owners each year, can be costly.  Today, we are an LLC and considering becoming an S-Corp.

Today, I teach my clients and students to consider three things in determining their business entity:

  1. Tax implications – what will your chosen entity mean when you file your taxes?
  2. Costs to form and maintain – what will it cost you to establish and maintain your chosen entity?
  3. Legal liability – what protections are afforded you based on your chosen entity?

When I got Andrea’s question, I couldn’t wait to share my two cents with her in an episode of Incredible Factor TV:

“Hi Darnyelle.  How do I legally develop an international offline and online business?”

Check out my response to Andrea’s question here:

For the record, as I share in the episode, I am not an attorney and I don’t play one on TV, so I don’t want this to be construed as legal advice. My personal recommendation would be to consult an attorney to make sure you choose the most appropriate legal entity for you.  Once you have your legal structure, you’ll want to also ensure that the IRS provides you with an EIN – employer identification number. It’s like your business’ social security number.  Then, you’ll want to stay on track with your taxes and reporting to maintain and protect your status.

I promised Andrea that I would shed some light on the various options for her to consider.  I will share about the most common ones amongst entrepreneurs:

  • Sole Proprietor – This is the simplest way to organize a business, and it’s the most common as well.  While we’re referring to this form as a business entity, it really is not a separate entity from the business owner, as other choices are.  It’s best for a single-owner business looking to get started quickly and inexpensively.  The only cost involved is setting up a DBA (Doing Business As), if you’re doing business under a business name other than your name, which usually just consists of filing and advertising your intentions – typically no more than $100 total. The biggest potential downside is liability.  Because you’re doing business under your own name and social security number, all liability falls on you personally.  If you choose this form, everything from company debts to lawsuit liabilities will be your personal responsibility, so even if you’re anxious to get started, you might want to seriously consider another entity form.
  • Limited Liability Corporation (LLC) – An entity form that has gained in popularity in recent years is the LLC.  As with all business forms, it has its major advantages and disadvantages.  First, as the name suggests, this business form serves to limit the personal liability of the owner or owners.  One exception to this rule is that some courts have found that single-member LLCs do not protect that single owner from personal liability.  So again, it’s important to check with an attorney to make sure you’re protected.  Another advantage of the LLC is something called “pass-through tax” treatment.  This means that the profits and losses of the company typically pass through to the LLC members, avoiding double taxation.  In other words, you pay personal taxes rather than both personal and corporate tax on the same profits. As for disadvantages, there are a few that are important to consider.  First of all, if you plan on seeking out investors, an LLC is most certainly not the way to go.  VCs and other investment partners do not typically consider investing in pass-through entities.  Also, LLCs can be very complex when it comes to taxes and accounting.  Each state’s tax rules for LLCs vary, but they are usually, if not always, very complex and ever-changing.  The cost of setting up an LLC isn’t outrageous, but depending on how much you’re bootstrapping it can be significant.
  • S-Corporation (S-Corp) – When you form an S Corp, you are forming a legal entity that exists separate from the owners of the company.  An S Corp is similar in that way to a C corporation, and like a C Corp or an LLC, the S Corp is set up according to the laws of the state in which it is formed.  The difference is that you’ll file an election with the IRS to form an S Corp.  Like the LLC, the S Corp is a pass-though entity, which is one of its advantages, as it avoids double taxation.  Another significant advantage to this corporate form is that it protects its owners from personal liability, and that protection has consistently been upheld in the courts.  Lastly, an advantage of the S Corp is that it is easy to convert it to a C Corp, which is the entity preferred by investors.

As you can see, determining which option listed here or the others to choose takes some consideration.  Talk with an expert so that you make a choice that will grow with your business.

So, now I want to hear from you; what’s your two cents?  Which entity did you choose for your business and why?  If you’re still a sole proprietor, how is that working for you?

©2014 by Darnyelle A. Jervey. All Rights Reserved. Darnyelle A. Jervey, MBA, The Incredible Factor Business Optimization Coach and Mentor, is the founder of Incredible One Enterprises®, Incredible Factor University® and the Leverage Your Incredible Factor System®, a proven step-by-step program so you experience financial and spiritual abundance in your life because of your business. For more information and a FREE audio CD “7 Critical Mistakes Even Smart Entrepreneurs Must Avoid for Clients, Connection and Cash Flow!” just fill out the form below.

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